Purchase Transaction:
A purchase transaction is a transaction between two parties related to one purchasing a good or service to the other. The complete purchase is constituted of one or several transactions. The following are examples of purchase transactions: a purchase order, in which the buyer declares its intention make a purchase to the supplier; a bill of lading, by which the seller claims to have delivered the ordered goods or services; an invoice, by which the seller inform the buyer of the due amount; and a payment, by which the buyer compensate the seller for the goods or services
Procurement Contracts:
Most business-to-business transactions are ruled by contracts. A procurement contract is a contract between two parties, one referred to as the seller, the selling party, the supplier, or the vendor, and the other referred to as the buyer, the buying party, the client, or the customer. A procurement contract give the buyer, under certain conditions, the right to place purchase orders to the suppliers, and the obligation, under certain conditions, for the supplier to fulfill these orders by delivering the requested goods or services. A procurement contract specifies how the payments between the parties as a compensation for the goods or services delivered should be computed. The goods or services that are the object of the contract are called the contracted items.
Note that in some industries, it is custom to call “procurement contract” a document that contains a number of terms and conditions between the parties, but that does not contain the list of items that are under contract, nor, a fortiori, their prices. Such a contract is meant to be accompanied by another document, sometimes called a blank purchase order or pricing schedule, that does specify the items and how to compute payments. This is not the sense in which we use the term procurement contract in this document: we will always mean a complete document, specifying the parties, the terms and conditions, the contracted items, and how to compute payments.
The rules that determine the payments between the parties vary widely in sophistication. At the simplest, contracts may simply list unit prices for each of the contracted items. Sometimes, these prices may depend on external indices, such as commodity price indices.
Contracts may also include conditional offers, which are clauses that tie a trigger condition to an effect. For example, the ongoing prices may drop as a result of the cumulative past volume crossing a threshold.
Spot Markets:
Businesses also make purchases to supplier with whom they do not have a procurement contract. This can be for a variety of reasons. For example, when the supplies they need are standard enough, they may choose not to contract any supplier so as to be able to chose the immediate cheapest for each transaction. Or it may be that the volumes to be purchased are low enough that the costs associated with the contracting process become prohibitive. In some circumstances, it may be that the buyer has one or more contracted suppliers for a given good or service, but that at a specific time the contracted suppliers are not able to provide the contracted good or services. In this case, the buyer will often make an exceptional purchase with a non-contracted supplier.
The market for one-time, immediate or near-future deliveries of goods or services, outside of any procurement contract, is called the sport market for these goods or services. The prices of these goods or services on the spot market are called the spot prices.
Expressive Sourcing:
Sourcing is the process by which a firm or other organization makes strategic decisions about which suppliers to contract with for goods, services, and other items that are purchased on an ongoing basis. In addition to determining which suppliers, it is during sourcing that a firm makes decisions about the kinds of goods and services to buy, together with the cost basis for purchases along with necessary contracting details (e.g., terms of payment, delivery times and so on.)
For example, a hospital system may decide to enter into an exclusive contract with a new supplier of artificial knees, while at the same time deciding to split an allocation for generic pharmaceutical supplies between two suppliers to mitigate risk while still taking advantage of volume discounts. A large multi-national company may source sea freight capacity and trucking capacity, perhaps adopting new shipping routes in the process if this network redesign provides cost benefits.
Sourcing is a strategic decision, in the sense that it is a complex, multi-faceted decision and one without an immediate impact on the “bottom line” of a business because no goods are purchased during the sourcing itself. Rather, sourcing determines winning suppliers along with contracts that will then executed against during procurement. That is, the outcome of a sourcing event is a set of procurement contracts. In comparison, procurement—the process of actually ordering goods and services, making payments and receiving delivery of goods and services—is tactical in that it directly impacts day-to-day operations of a business and incurs direct costs to the bottom line.
Sourcing was traditionally a manual process by which a sourcing team would negotiate deals through discussion and exchange of proposals and counterproposals, or by otherwise issuing a request for proposal (RFP) from prospective suppliers. The advent of the Internet has facilitated the use of electronic markets to dramatically improve the efficiency of sourcing. Businesses are moving to electronic sourcing (e-Sourcing), electronic contract management, and electronic procurement practices in hopes of reducing or eliminating cost from the procurement process. Early systems provided the ability to easily run “reverse auctions”, i.e., an auction with one buyer and competing sellers, where a sourcing contract was allocated to the buyer with the lowest price bid. More elaborate systems allowed for scoring rules to make adjustments to capture buyer preferences, for example for one supplier over another.
A significant advance in recent years is provided by expressive sourcing, in which many different kinds of goods and services can be sourced at the same time and with optimization used to determine the optimal outcome of a sourcing event. Rather than pre-bundling goods and running one reverse auction for each bundle of goods (e.g., all surgical knees), the use of expressive sourcing allows for surgical devices, generic drugs, and other medical suppliers to be flexibly sourced. Through appropriately designed bidding languages each supplier can submit bids on the goods and services that it wants to supply, and these bids can then be combined at the end of the auction with optimization used to determine the set of winning suppliers and an allocation of goods to suppliers to maximize business value to the buyer.
The bid of a supplier can be constructed in an expressive language that allows for side-constraints, volume-based discounts, and other adjustments. For example, the bid from a supplier might include the following kinds of discounts and constraints: multi-item quantity discounts; e.g., if 1000 units of items A and B are procured then the unit price will fall by 5% on future purchases of A, B and C; multi-item dollar-volume discounts; e.g., if $100,000 of items A and B are procured then the unit price will fall by 5% on future purchases of A, B and C; multi-item capacity constraints; e.g., I cannot supply more than 25 shipments in total from ports A or B to C or D; multi-item market-share discounts; e.g., if my market-share of items A and B is at least 20% then I will provide a rebate of $50,000; growth-based discounts; e.g., if the number of units of item A that I sell increases by 5% from this year then I will provide a rebate of $10,000; multi-item single-order tiered pricing; e.g., if 1000 units each of items A and B are purchased in a single purchase order then the per-unit price is 5% less; and package bids; e.g., if you buy an A to B trip at the same time as a B to A trip then my price is 10% less on that round trip (because the trucker avoids the “dead-head” cost.)
The sourcing event itself may also be multi-stage, with a second and subsequent round of bid collection from prospective suppliers.
The outcome of a sourcing event specifies both an allocation of goods to each supplier (i.e., the quantity of each good or service to be purchased from each supplier during the course of a contract) the set of winning suppliers, and the bids provided by each winning supplier. This bid information includes for example all base prices along with any additional expressive bid information, such as described in the examples above.
In addition to specifying projected quantities of goods and services that will be purchased during the term of a contract, the buyer (e.g., the sourcing team) is also able to provide adjustments and constraints that are considered when determining the outcome of the sourcing event. Inputs provided by the buyer can include bid adjustments (for example imposing a 3% downward price adjustment on bids from incumbent suppliers to promote incumbents), or constraints (such as requiring a split allocation against two or more suppliers, fixing some part of the allocation and not leaving it flexible, or a max-supplier constraint).
A computational optimization procedure is used to determine the outcome of a sourcing event, in a process referred to as winner determination. This is the process by which the outcome of an event is determined. The final outcome may be reached through an interactive process in which a sourcing team explores the impact of different (bid-taker) adjustments and constraints, with the optimization used interactively to determine the outcome.
Procurement Plans:
Typically, the sourcing and legal teams of a buyer do more than contracting suppliers. They also generate some information related to the intended or expected use of these contracts. A procurement plan is all the information possessed or produced by the buyer that is related to the future procurement to be made in connection with the procurement contracts A procurement plan can also include information related to the future procurement by the buyer against non-contracted suppliers. The nature of this information can vary widely. A plan for future procurement is often made in relation to a forecast of the future quantities of the various items to be ordered, across all contracted suppliers for each item. For example, “we forecast we will buy 1000 units of item A in the year to come”. A few examples of procurement plans include:                an allocation of forecasted future quantities of items (e.g., goods or services) to the various contracted suppliers, as absolute. For example, “we forecast we will buy 1000 units of item A in the year to come, and we intend to order 350 units from supplier X and 650 from supplier Y”. These quantities—here 350 and 650—are the target quantities: the goal is that the actual quantities should be close to the target ones.        an allocation of forecasted future quantities of items (e.g., goods or services) to the various contracted suppliers, as fractions of the actual total quantities. For example, “we forecast we will buy 1000 units of item A in the year to come, and we intend to order 35% of the actual quantity from supplier X and 65% from supplier Y”. These fractions—here 35% and 65%—are target fractions. The goal is that the actual fractions should be close to the target ones.        some more or less flexible guidelines about how to use these contracts. For example, “for item A, whenever possible, prefer supplier X to supplier Y”.        Some strict rules about how to use these contracts. For example, “when ordering item A, always ask supplier X first. Only if supplier X is unable to deliver the requested goods can supplier Y be given an order.”        Some rules about how to use a contract, making explicit use of a target allocation specified by a procurement plan. For example, if the sourcing team decided to allocate 35% of item A to supplier X and 65% to supplier Y, such a rule could be: “if the year-to-date fraction of A ordered from X is greater than 45%, place any order of A to Y. If it is less than 25%, place any order of A to X. Otherwise, use your personal judgment.”        
This wide diversity should not hide the common characteristics of all these plans: they all concern the future use of contracts, parameterizing different methods of future procurement that are operable to the plan. Typically, this information is kept privately by the buyer, although he may choose to share some of it to some suppliers (or sellers).
Procurement Systems:
At the end of a sourcing event the buyer enters into contracts with the suppliers for items and pricing under certain terms and conditions. Around 75% of all business to business transactions are governed by formal contracts or trade agreements with a typical Fortune 100 company maintaining between 20,000 and 40,000 active contracts. Contracts capture negotiated terms with suppliers, which may not be those exactly identified in a sourcing event. Contracts also provide a framework to measure operational and financial performance, while forming the basis for regulatory compliance such as Sarbanes-Oxley Act of 2002 (SOX).
Contract management systems provide a specialized digital document repository and also allow for the management of the “red-lining” process of contract negotiation and have sections for disclaimers and so on. Current contract management systems support “line-item prices”, i.e. fixed prices for different units of various goods and services. Each contract at a minimum has: a term (i.e., a range of valid dates), a buyer, a supplier, and a description of prices (e.g., line-item prices) for purchasing the items (e.g., goods, services) from the supplier for the term. The current state-of-the-art contracting systems do not typically capture all of the expressive or conditional offers that may be selected at the outcome of sourcing and the associated expressive contracts entered into with suppliers. For example, most contract management systems fail to implement line-item volume quantity discounts, line-item dollar-volume discounts, quote-order line-item volume discounts, multi-item capacity, multi-item quantity volume discounts, split allocations, and so on.
Upon completion of the contracting process the procurement system is configured. This is the system used by buyers within an organization to purchase goods and services on an ongoing basis. The procurement system is typically populated at present with a line-item listing of the prices to be paid for an item from a supplier. But current procurement systems are not able to receive as an input the various forms of expressive offers, and associated expressive contracts, that are generated as the result of the optimization-based expressive auctions used frequently within sourcing.
This mismatch in expressiveness—between sourcing and procurement—is a source of inefficiency in current procurement processes. An example of such inefficiency resulting from non-expressive procurement processes, i.e., one with non-expressive contracts, is that suppliers should be expected to anticipate that volume discounts and other forms of expressiveness that are provided within an expressive sourcing event will be provided to buyers based only on forecasted quantities upon conclusion of sourcing, which may not in fact be realized. In the status quo, the expressive bids, for example volume discounts that trigger at different volume thresholds, are sometimes “flattened out” to a single line-item price based on this forecast. The status quo at present is that upon the outcome of a sourcing event the Chief Procurement Officer (CPO) within an organization reports a particular savings achieved, while the Chief Financial Officer (CFO) at the end of the year does not eventually see the savings. The mismatch could be for reasons not related to suboptimal procurement decisions, for example because the quantity of materials purchased was higher than anticipated, because the spot price of materials changed, or because an existing item was replaced with a different item and possibly at a different quantity. But this can also frequently occur because a volume discount was not realized because procurement was made to the wrong contract, or because it was made to the correct contract but without triggering a new price point to be updated within the procurement system. This difference between the savings numbers considered by the CPO and the CFO is the “savings leakage”.
The savings leakage can increase as the commodities become more strategic and complex. Price discounts and other complex offers that are negotiated via the sourcing event may be neglected during procurement. For example, whereas the intent of a sourcing team may be that procurement of one kind of good should be from supplier 1 and not supplier 2 because it will trigger a volume discount at some future aggregate spend quantity, this information may not be available to individuals involved in procurement. It often takes an audit once a month to catch the fact that a price change should have occurred. Once found, the buyer must prove to the supplier that the new price has been achieved and then must get the supplier to update pricing. This often leads to a 30-120 day delay in getting the new lower pricing. This situation is compounded by the fact that typically the procurement systems, sourcing systems, and finance systems (e.g., accounts-payable, accounts-receivable) are not interconnected, and moreover that in many complex organizations there are many different systems for one purpose (e.g., multiple purchase order applications). This leads to an inability to track contract utilization and makes supplier performance tracking cumbersome and time-consuming.
Contract Compliance:
Contract compliance is a general term that is traditionally used to describe the process by which procurement decisions are validated against the contracts generated upon the completion of a sourcing event. The current state of the art in contract compliance is to provide tracking of procurement decisions and compare against quantity and price projections in order to monitor the “savings capture,” i.e., what amount of identified savings from sourcing are actually achieved or realized during procurement.
Current compliance systems are designed to perform monitoring of the purchase orders that are generated by procurement systems, and will in turn generate reports that provide information about, without limitation, the following kinds of concerns:                Maverick Buying: This occurs when a buyer purchases something off contract. A purchase order contains an item that is under contract, but the purchase order is not associated with this contract or the item is under a contract with a different supplier. The end effect is that the contracted price benefits may not be achieved.        Purchase Order-Contract Price Discrepancy: The price that goes out on a purchase order does not match the contract price.        Invoice-Purchase Order Price Discrepancy: The price from the supplier on the invoice does not match the price on the purchase order.        Contract utilization: Is the spend consistent with the forecasted volume?        
However, current contract compliance systems cannot handle the semantics of expressive contracts.
In monitoring procurement decisions, compliance systems typically monitor the transaction network over which information such as purchase orders flow. Information may be in the form of contract XML (cXML) flowing over electronic clearing networks, or electronic data interchange (EDI) standards over a closed network, or via purchase orders (POs) and invoices exchanged between the buyer and the supplier. A PO originates from the procurement system and is sent back-and-forth with the supplier until approved and accepted. When the items are delivered, the supplier sends an invoice for the PO. This invoice is again exchanged back and forth with the buyer until it is approved and accepted.
Current compliance systems track purchases associated with POs and are designed to try to work around problems that can occur, such as POs with missing material numbers or with only free-text descriptions. In some cases, POs may also be missing completely in which case information from invoices can take their place. In some cases there may be no invoice at all, but just purchasing information provided to a compliance system by a supplier. All of this affects the degree of accuracy possible in tracking the state of contracts. Methods from artificial intelligence are sometimes adopted; e.g., to perform automated classification of items into different spend categories and to allow for reporting via this taxonomy.